2. DEFINITIONS OF ACCOUNTING
“The process of identifying, measuring, and communicating
economic information to permit informed judgements and decisions
by users of the information.”
American Accounting Association (AAA)
“A service activity whose function is to provide quantitative
information, primarily financial in nature, about economic entries
that is intended to be useful in making economic decisions.”
American Institute of Certified Public Accountants (AICPA)
3. PRIMARY FUNCTIONS OF ACCOUNTING
• Recording data about business transactions
In the Egyptian era they used a quill pen to record the data and
stored it on papyrus scrolls. Today we might use a bar code and scan
data into a computer system and store it on a magnetic disk.
• Summarizing results of business activity into useful report: The
balance sheet and income statement have been standard reports for
many years. More recently we added a statement of cash flows.
However managers in today’s environment demand more detailed
reports like sales by district or sales by product type.
4. • Providing assurances that the business is operating as
intended and that the assets of the organization are
protected. All parties to a business event have looked to
accountants to provide assurance that the transaction is
properly handled, accurately recorded, and accurately
reported. Throughout most of this century the assurance has
been based on a system of internal controls and an audit of
the published financial statements.
5. ACCOUNTING AS AN AID TO DECISION MAKING
• Accounting helps in decision making by showing where and when money has
been spent, by evaluating performance, and by showing the implications of
choosing one plan instead of another.
• Fundamental relationships in the decision making process
Event
Accountant's
analysis and
recording
Financial
statements
Users
7. FLOW OF ACCOUNTING INFORMATION
• Accounting systems are designed to meet the needs of
the decision makers who use the financial information
• Every business maintains some type of accounting system.
• These accounting systems may be very complex or very simple,
but the real value of any accounting system lies in the
information that the system provides.
8. USERS OF ACCOUNTING INFORMATION
Individuals Businesses
Investors and
creditors
Government
regulatory
agencies
Taxing
authorities
Nonprofit
organizations
9. USERS OF ACCOUNTING INFORMATION
(CONTINUED)
• Financial accounting
• External users (Make decisions about the entity)
• Investors
• Creditors
• Regulators
• Customers
• Competitors
11. FINANCIAL ACCOUNTING
• It’s focus is on reporting to external parties.
• It measures and records business transactions
• It provides financial statement based on generally
accepted accounting principles.
13. DEBIT AND CREDIT ENTRIES
• Debit and credit are formal book keeping and accounting terms. They are the most fundamental concepts
in accounting, representing the two sides of each individual transaction recorded in any accounting
system.
• A debit transaction indicates an asset or an expense transaction, a credit indicates a transaction that will
cause a liability or a gain. A debit transaction can also be used to reduce a credit balance or increase a
debit balance. A credit transaction can be used to decrease a debit balance or increase a credit balance.
• Debits and credits are a system of notation used in accounting to keep track of money movements
(transactions) into and out of an account. Traditionally, an account's transactions are recorded in two
columns of numbers: debits in the left hand column, credits in the right. Keeping the debits and credits in
separate columns allows each to be recorded and totaled independently. The smaller of the two totals is
then subtracted from the larger to give the account balance. An account may thus have a balance either
the debit or credit side.
15. INCOME STATEMENT
• An income statement communicates information about
business’s financial performance by summarizing revenues
less expenses over a period of time.
• Income Statement Equation
• Revenues-Expenses=Profit/Loss
16. INCOME STATEMENT
• Income statements should help investors and creditors determine the past performance of
the enterprise, predict future performance, and assess the capability of generating future
cash flows.
• However, information of an income statement has several limitations:
• Items that might be relevant but cannot be reliably measured are not reported (e.g. brand
recognition and loyalty).
• Some numbers depend on accounting methods used (e.g. using FIFO or LIFO accounting to
measure inventory level).
• Some numbers depend on judgments and estimates (e.g. depreciation expense depends on
estimated useful life and salvage value).
18. SUMMARY OF ASSETS VS. LIABILITIES
• Assets are the purchases an organization makes to improve their financial
position or assist in their operations. Liabilities are the amounts a company
owes to external entities.
• Assets and liabilities are both taken into consideration to reflect the true
financial position of a company.
• The assets of a company are also used to determine the credit scores of a
company among other factors.
• Comparisons within different firms can also be done accurately with the balance
sheet that displays both the assets and liabilities.
• Assets include land, buildings, plant and machinery, inventory and can all easily
depreciate in value. Liabilities include loans, debentures, accounts payables and
can’t depreciate.
19. DOUBLE-ENTRY BOOKKEEPING
• When running the model you will now notice that every flow starts and
ends in a tank. This means that every accounting transaction "comes out"
of one balance and "goes into" another. This is a general principle of
accounting called the principle of double-entry bookkeeping. At the end of
this lesson we will look at how this is linked to debiting and crediting.
• Another thing you may have noticed in the model is that every balance is
initially zero. This corresponds directly to the fact that when a business is
created every balance is zero. Every subsequent transaction in the business
will fill one tank and drain another.
20. ASSETS, LIABILITIES & EQUITY
• Assets = Liabilities + Equity
• A good way to think about the equation is to think that everything that a
business owns (its assets) it also owes (its liabilities and equity). The amounts owed are
a combination of actual legal debts to employees or suppliers, and the profit that a
business has generated which from an accounting perspective is owed back to the
company's owners.
• This equation is called the Fundamental Equation of Accounting. As we have seen
using the model, it is a simple result of double-entry bookkeeping and the initial value
of zero for every balance.
21. OTHER ACCOUNTING EQUATIONS
• The extended accounting equation reflects the three sources of funds to the business - total
liabilities, equity and retained earnings:
• Assets = Total Liabilities + Equity + Retained Earnings
• Total Liabilities can be subdivided as current and long-term liabilities then the extended
accounting equation becomes:
• Assets = Current Liabilities + Long Term Liabilities + Equity + Retained Earnings
• To complete the listing of items in the extended accounting equation we proceed to
breakdown “Assets” into current assets and fixed assets.
• Current Assets + Fixed Assets = Current Liabilities + Long Term Liabilities + Equity +
Retained Earnings
